The Lewis Theory of Development

Question: Examine Lewis Dual Sector Model of Development. Answer: The Lewis Dual Sector Model of Development Lewis theory of economic development is a structural- change theory. This theory explains the mechanism of changing structure of underdeveloped economics from subsistence agriculture to more modern and more urbanized. This model became the general theory of the development process for surplus labor nation during 1960s and early 1970s. Basis model Lewis model consists of two sectors in the economy. They are i)

Traditional Sector: This sector is overpopulated subsistence sector where marginal productivity of labor is zero. Due to zero marginal productivity of labor it is possible to withdraw labor from this sector without affecting the level of output. This is why Lewis classified this sector as surplus labor sector.

ii)

Modern sector: This sector is urban industrial sector. Productivity is high in this sector. Labor is gradually transferred into this sector from traditional sector. Movement of labor from traditional to modern sector brings the expansion in both out put and employment. The speed of this expansion depends on a) Rate of industrial investment and capital accumulation which ultimately depends on the level of profit. Lewis assumes that all profits are reinvested. b)

Wage of difference between rural sector and urban sector. According to Lewis there should be at least 30 present higher wage rates in urban sector than rural sector in order to transfer labor automatically from rural to urban sector. Lewis assumed that perfectly competition labor market in modern sector giving fix wage rate and horizontal supply curve of labor. On the other hand wage rate in the traditional sector is given average productivity of labor( w= APPL= TP/L)

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We can explain Lewis model in two sector economy with the help of following diagram. Right panel of the fig. represent traditional sector. Upper right fig. is production function. The production function is typical with horizontal segment beyond maximum total product. Traditional sector production depends on labor (Variable factor) and capital and technology (fixed factor). The corresponding marginal and average productivity of labor are shown in lower right fig. wage in traditional WA, sector is equal to average productivity of labor with the assumption that total product is equally distributed among all employed labor. With the wage rate WA, the equilibrium amount of labor is LA. Labor more than LA is excess labor. These excess labors are responsible for horizontal section of the production function. Hence they can be transferred to modern sector without reducing output in traditional sector.

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In the modern sector, represented by left panel diagram, production is the function of labor. Capital and technology is fixed in this sector as well. In the beginning this sector is producing with total product curve TPM(KM1). The corresponding marginal product curve is MPL1. Since labor market is perfectly competitive, marginal productivity curve is demand for labor curve as well. Similarly supply curve is horizontal straight line represented by fixed wage WM. demand and supply curves interacts at point S giving equilibrium quantity of labor L1. With this quantity of labor and given production function, total output is given by area under curve PS. Similarly total cost of production is given by under WMS. Hence profit is area PSWM. This accrued profit is reinvested. With the new investment, production function shift upward to TPM(KM2). With this new margin product curve both employment (L2) and output (area under QT) along with profit increases. The requirement labor is brought from traditional sector. Hence both employment and output increase in the economy. The increased profit is again reinvested. This process continues giving self sustained growth until the surplus labor is absorbed in the new industrial sector. Criticism of the model Although this model got very warm welcome during 1960s and 1970s, it is criticized for its assumptions. Following are the major points of criticism. i)

Capital accumulation: this model assumes that the rate of the labor transfer, employment creation and output expansion depends on the rate of capital accumulated in modern sector. Rate of capital accumulation depends on the level of profit. Higher the profit higher will be the rate of capital accumulation. But there are two major problems with this process. First what will happen in profit is reinvested in laborsaving capital equipment? In this case output and profit will expand but employment will not expand. Hence owners of capital will be richer and richer leaving rural people poor. GNP will increase but aggregate social welfare will not improve. The second problem is that this model assumes all profit is reinvested. But there is possibility that if business environment is not optimistic within the economy, there may be

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capital flight. Entrepreneur may deposit accrued profit in western banks. In this situation there is no chance of expansion of output and employment according to the prediction of model. ii)

Surplus Labor: Lewis assumed that there is surplus labor in the rural economy and full employment in the urban sector. But many researches have shown that there is little general surplus labor in rural locations.

iii)

Competitive labor market in modern sector: Lewis model assumes competitive labor market in modern sector. The implication of this assumption is that supply of labor is perfectly elastic. But historically it has been observed that there is tendency continuous rising wages level in almost all developing countries due to the institutional factors such as union bargaining power, civil services wage scales, multinational companies hiring practices etc.

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